An Agricultural Law Research Article

[Pages:28]University of Arkansas System Division of Agriculture

NatAgLaw@uark.edu $ (479) 575-7646

An Agricultural Law Research Article

Cooperative Mergers and Consolidations: A Consideration of the Legal and Tax Issues

by

Kathryn J. Sedo

Originally published in NORTH DAKOTA LAW REVIEW 63 N.D. L. REV. 377 (1987)



COOPERATIVE MERGERS AND CONSOLIDATIONS:

A CONSIDERATION OF THE LEGAL AND TAX ISSUES

KATHRYN]. SEDO*

I. INTRODUCTION

The financial CrISIS in rural America has been well documented. Farmers faced with large debt service at high interest rates and low prices for their crops are financially threatened. The businesses that serve farmers either through the provision of supplies and services or through the marketing of their products are also in financial trouble. Cooperative marketing and supply associations are not exempted from the general financial crisis that engulfs our rural areas. From 1976 to 1985, 1994 cooperatives were removed from the lists of the United States Department of Agriculture, Agricultural Cooperatives Service.! The reasons for removal from the list, which presumably means the cooperative is no longer in existence, and the number of cooperatives for each reason in parenthesis are: (1) gone out of business (773); (2) merger or consolidation (357); (3) acquisition (242); (4) other (622).2 The "other" category includes cooperatives that were inactive, no longer operating as a cooperative, originally

? A.B., 1974, University of Michigan; ] .D., 1976, University of Michigan; Associate Clinical Professor of Law, University of Minnesota, Minneapolis, Minnesota.

I would like to extend my appreciation to my current research assistant, Toni Halleen, and a past research assistant, Daniel Solomon, for their help in researching this Article. In addition, I would like to acknowledge Dean Robert A. Stein of the University of Minnesota Law School for providing me with research funds and moral support. Finally, I would like to thank Ralph K. MQrris ofSt. .Paul, Minnesota for always being willing to discuss issues of cooperative law with me. I remain responsible, of course, for the content of this Article and the opinions contained in it.

I. Letters from Charles A. Kraenzle, Director of the Cooperative Management Division of the Agricultural Cooperative Service, to Kathryn]. Sedo (Aug. 13, 1986 and Sept. 9, 1986). During the same time period, 1976 to 1985, 76 cooperatives were added to the list of the A!\"ricultural Cooperative Service. Letter from Charles A. Kraenzle, Director of the Cooperative Management Division of the Agricultural Cooperative Service, to Kathryn]. Sedo (Sept. 9,1986). In 1985, the Service had 5617 cooperatives on its list. /d.

2. Letter from Charles A. Kraenzle, Director of the Cooperative Management Division of the Agricultural Cooperative Service, to Kathryn]. Sedo (Aug. 13, 1986).

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misidentified as a cooperative, or no longer in business without any reason being provided. 3 The majority of cooperatives in the other category were inactive cooperatives.

The initial response of any business to financial adversity is to contain expenses. If cost containment is unsuccessful, cooperatives have two options: (1) some form of merger or acquisition or (2) dissolution or bankruptcy. All states and the District of Columbia have incorporation laws governing agricultural cooperatives,4 and many of these statutes contain provisions regulating the merger, acquisition, and dissolution of cooperatives. 5 This Article will explore the legal issues surrounding merger and acquisition of cooperatives.

II. CHARACTERISTICS OF COOPERATIVES

Cooperative associations are member owned and controlled.6 They may be either stock or nonstock associations, although generally they issue stock. In the agricultural context, for the most part, members of the cooperative are farmers or agricultural

3. [d. 4. For a detailed analysis of state incorporation statutes for cooperatives and their provisions, see ]. BAARDA, STATE INCORPORATION STATUTES FOR FARMER COOPERATIVES (Cooperative Information Report No. 30). 5. At least twenty-eight states refer to merger or acquisition in their cooperative incorporation statutes. See ALASKA STAT.S 10.15.400 (1985); ARK. STAT. ANN.S 77-1028-29 (1981); CAL. CORP. CODE S 12530 (West Supp. 1987); COLO. REV. STAT. S 7-55-112 (1986); CONN. GEN. STAT. ANN. S 33-206 (West 1987); HAW. REV. STAT. S 421-21.5 (1985); IDAHO.CODE S 22- 2622A (1977); ILL. ANN. STAT. ch. 32, para. 470 (Smith-Hurd Supp. 1987); IND. CODE ANN. S 15-7-1-8 (Burns Supp. 1986);

IOWA CODE ANN. S 499.69 (West Supp. 1987); Ky. REV. STAT. ANN. S 272.301, 272.305

(Michic:/Bobbs-MerrillI981 & Supp. 1986); ME. REV. STAT. ANN. tit. 13S 1951 (1981); MD. CORPS. & ASS'NS CODE ANN. S 5-527(a1 (19851; MINN. STAT. S 308.15(4) (1984); MONT. CODE ANN. S 35-17 501 (1985); NEv. REV. STAT. S 81.130 (1982); N.J. STAT. ANN. S 4:13-10 (West 1973); . N.C. GEN.

STAT. H 54-159, 54-160 (1982); N.D. CENT. CODE S 10-15-41(1985); OR. REV. STAT. S 62.610

(1985); PA. STAT. ANN. tit. 15, S 12129 (Purdon Supp. 1987); S.D. CODIFIED LAws ANN. S 47-18- 1 (1983); TENN. CODE ANN. S 43-16-147 (1980); UTAH CODE ANN. S 3-1-30 (1982); VT. STAT. ANN. tit. 11, S 1061 (1984); VA. CODE ANN. S 13.1-339 (1985); WASH. REV. CODE ANN. S 23.86.220 (West Supp. 1987); WIS. STAT. ANN. S 185.61 (WestSupp. 1986).

6. I. PACKEL, THE.LAW OF THE, ORGANIZATION AND OPERATION OF COOPERATIVES 4-5 (1970). Packel describes cooperatives as havin~ the followin~characteristics:

-control and ownership of each member is substantially equal; -members are limited to those who will avail themselves of the services furnished by the association; -transfer of ownership interests is prohibited or limited; -capital investment receives either no return or a limited return; -economic benefits pass to the members on a substantially equal basis or on the basis of their patronage of the association; -members are not personally liable for obligations ofthe association in the absence of a direct undertaking or authorization by them; -death, bankruptcy or withdrawal of one or more members does not terminate the association; and -services of the association are furnished primarily for the use of the members.

!d.

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producers. Each member of the cooperative has one vote regardless of the number of shares owned or amount of equity in the cooperative. 7 Dividends on stock or equity are limited, generally by statute. 8 Any surplus or profit9 that is generated by the cooperative is distributed among the members according to their respective patronage of the cooperative and not according to the amount of equity that the member may have in the cooperative. 10 Thus, a cooperative is owned by its member-patrons who democratically control it and share in its surplus based on their use of the cooperative.

The most common types of cooperatives serving agricultural producers are marketing and supply cooperatives. II A marketing cooperative operates, as a rule, by purchasing the products of the farmer or agricultural producer. It may then store, pool, process and market the product. At the end of the year, an accounting is made to the member-patrons and the surplus, which is the net savings after expenses and dividends are paid, is distributed to member-patrons in cash and some form of equity credit or stock in the cooperative. This distribution of cash and equity credit is called a patronage dividend. 12

A supply cooperative, which mayor may not be operated as part of a marketing cooperative, provides goods and services that are used in farming operations. 13 Fertilizer, seeds, gasoline and other petroleum products, equipment, pesticides, and insecticides are a few of the types of products available to farmers on a

7. I. PACKEL, supra note 6, at 106-07; see also T. WHITNEY, AGRICULTURAL COOPERATIVES 18 (Practicing Law Institute Corporate Law and Practice Course Handbook Series No. 306, 197~).

8. See, e.g., N.D. CENT. CODE S 10-15-20 (1985)(limiting dividends to six percent). While North

Dakota limits dividends to six percent per annum, many states restrict dividends to eight percent a

year. See, e.g., MINN. STAT. S 308.06 (1984) (limiting dividends to eight percent). See generally

BAARDA, supra note 4, at 112-13 (statutory dividend limitations). This eight percent limitation is also

the rate contained in the Capper-Volstead Act. Capper-Volstead Act, 7 U.S.C. S 291 (1982). For a

discussion of the Capper-Volstead Act, see infra notes 71-73 and accompanying text.

9. Because of the unique structure of cooperatives it is more accurate to term the excess revenue that a cooperative generates as surplus rather than profit. I. PACKEL, supra note 6, at 186-92. The

excess income of cooperatives belongs to the members of the cooperative since the excess revenue

results either from members paying too much for goods and services that they purchased or members receiving too little for goods or services that they contributed to the cooperative. See id. In either event the surplus that results is not a profit in the sense that the word is generally used.

10. T. WHITNEY, supra note 7, at 17.

11. See gprerally K. LIMVERE, ECONOMIC DEMOCRACY FOR THE.NoRTHERN PLAINS: COOPERATIVES AND NORTH DAKOTA 57-64 (1980) (discussing types of cooperatives).

12. See T. WHITNEY, supra note 7, at 18. The distribution of patronage dividends is usually

controlled by Subchapter T of the Internal Revenue Code. See 26 U.S.C.A. U 1381 to 1388 (1982 &

Supp. 1987). Cooperatives that meet the requirements set forth in subchapter T may deduct the

amounts paid out as patronage dividends from their taxable income. /d. S 1382(b) (1) (1982). 13. See K. LIMVERE, supra note 11, at 57. Supply cooperatives are also referred to as consumer

cooperatives. /d. at 57-58. Supply cooperatives often act not only as a purchasing cooperative, but

also participate in the production of the products that are provided to members. [d. Thus, a fertilizer

cooperative may extend to the mining and manufacturing offertilizer. /d.

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cooperative basis. Member-patrons purchase the products at market price. At the end of the year, the cooperative issues patronage dividends representing its surplus in cash and equity certificates or stock. a

III. UNIFICATION OF COOPERATIVES

A. DEFINITIONS

Cooperatives are unified in one of two ways. A merger is the combining of two or more cooperatives into one cooperative in which one of the cooperatives survive and the other cooperatives do not survive. 15 This can occur as a result of the surviving cooperative purchasing the stock of the acquired cooperative or as a result of the surviving cooperative purchasing the assets of the acquired cooperative. 16 A unification may also take the form of a consolidation. A consolidation occurs when two or more cooperatives combine to form a new cooperative, none of the "old" cooperatives surviving. I?

The form that the unification takes has legal and tax implications. As often is the case, the legal and tax consequences may dictate the form of the proposed unification.

B. LEGAL REQUIREMENTS

Most cooperatives are incorporated associations subject to individual state cooperative incorporation statutes. Many of these state incorporation statutes have provisions regulating the merger and consolidation of cooperatives. IS If the cooperative incorporat

ing statute does not have a provision governing merger and consolidation, the cooperatives may have to look to the state's business corporation statute for guidance. 19

14. SeeT. WHITNEY, supra note 7, at 17- 18. 15. See E. KINTNER, PRIMER ON THE.LAW OF MERGERS 27 (1973). 16. See id. 17. See id. 18. See supra note 5. 19. At least thirty-seven states provide that in the absence of specific prOVISIons in the cooperative incorporation statutes that the general incorporation statutes will apply except when the provisions are inconsistent with the cooperative incorporation statutes. See ALA. CODE ? 2-10-72 (1975); ARIZ. REV. STAT. ANN. ? 10-702 (1977); ARK. STAT. ANN. ? 77-1018 (19Bl); CAL. FOOD & AGRIe. CODE ? 54180 (West 1986); COLO. REV. STAT. ? 7-55-116 (19B6); CONN. GEN. STAT. ANN. ? 33-206 (West 1987); DEL. CODE ANN. tit. 3, ? 8505 (1985); FLA. STAT. ANN. ? 618.24 (West 1977); GA. CODE ANN. ? 65-222 (Supp. 1986); HAW. REV. STAT. ? 421-21.5 (1985); IDAHO. CODE ? 22 2620 (1977); ILL. ANN. STAT. ch. 32, para. 470 (Smith-Hurd Supp. 1987); IND. CODE ANN. ? 15-7-1 -28 (Burns Supp. 1987); KAN. STAT. ANN. ? 17-1628 (1981); Ky. REV. STAT. ANN. ? 272.211 (B) (Michie/Bobbs-Merrill Supp. 1986); LA. REV. STAT. ANN. ? 3:149 (West 1973); MD.

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Generally there are four statutory requirements for a merger or consolidation of cooperatives: (1) a plan of merger or consolidation; (2) approval of the plan by the board of directors of

each cooperative; (3) approval of the plan by the members of each cooperative; and (4-) filing of the plan with the appropriate state filing office. 20

The plan of merger or consolidation is the most important document. 21 It contains the agreements between the merging or consolidating cooperatives, the procedures to carry out the

agreements, and the effect of the merger or consolidation on all the members of each cooperative. As a general rule the plan also contains the names of the cooperatives, the name of the surviving

entity, any necessary amendments to the articles of incorporation

and bylaws of the surviving cooperative or the articles of incorporation and bylaws of the consolidated cooperative, the composition of the board of directors, the functioning of the merged

or consolidated cooperative, a valuation of equities, and a procedure for exchange of equities. 22

Each cooperative involved in the merger or consolidation generally appoints members to a committee which negotiates the content of the plan. 23 Once the negotiations are completed, the plan must be approved by the board of directors of each cooperative.

After approval of the consolidation or merger by the boards of directors, the next step is usually approval of the plan by the membership of the involved cooperatives. 24 Whether a simple

CORPS. & ASS'NS CODE ANN. ? 5-527(a) (1985); MASS. GEN. LAWS ANN. ch. 157, ? 3 (West. Supp. 1987); MINN. STAT. ? 308.05 (1) (1984); Mo. ANN. STAT. ? 274.290 (Vernon 1963); MONT. CODE ANN. ? 35-16-101 (1985); NEB. REv. STAT. ? 21-1414 (1983); N.H. REv. STAT. ANN. ? 27:301:51 (1977); N.J. STAT. ANN. ? 4:13-12 (West 1973); N.Y. CooP. CORP. LAW ? 5 (Conco!. Supp. 1987); N.C. GEN. STAT. ? 54-117 (Supp. 1985); OHIO REv. CODE ANN. ? 1729.27 (Anderson 1985); OKLA. STAT. ANN. tit. 2, ? 361w (West 1973); PA. STAT. ANN. tit. 15, ? 12129 (Purdon Supp. 1987); R.Y. GEN. LAWS ? 7-7-20 (1985); S.C. CODE ANN. ? 33-47-40 (Law. Co-op. 1987); TENN. CODE ANN. ? 43-16-144 (1980); TEX. AGRle. CODE ANN. ? 52.004 (Vernon 1982); VA. CODE ANN. 13.1-339 (1985); WASH. REV. CODE ANN. ? 24.32.310 (1969); W. VA. CODE ? 19-4-29 (1984); WYo. STAT. ? 17-10-125 (1987).

20. Larson, Le.!?al Requirements oj Mer.!?ersfor Cooperatives, MOVING FOOD, Feb.-Mar., 1985 at 24 25. See .!?enerally BAARDA, supra note 4, at 119-20 (discussing statutory requirements for mergers and consolidations).

21. Larson, supra note 20, at 25. 22. !d. In preparing the plan for merger or consolidation, a review of the following documents is necessary: the articles of incorporation and amendments; minute books; stock books and stockholders' or membership lists; tax returns and related tax documents; annual stockholder reports and audits; appraisals; surveys, and similar reports; collective bargaining agreements; employment agreements; employee benefit plans; license and franchise agreements and patents; leases; suppliers' and customers' contracts; loan agreements; revenue bond financing documents and mortgages; litigation files; and all other material contracts of each cooperative. R. Morris, Legal Checklist for Acquisition by a Cooperative Considering Merger, reprinted in Proceedings of the Legal-Finance Conference 38 (July 8-9, 1981) (University Center for Cooperatives, University of Wisconsin Extension). 23. See Larson, supra note 20, at 25. 24. See, e..!?, N.D. CENT. CODE ? 10-15-41 (1985)(requiring approval of stockholders for merger or consolidation).

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majority or a larger majority is needed to approve the plan is provided in the appropriate state statute. 25 Because not all state cooperative incorporation statutes have specific provisions for membership approval, or for merger and acquisitions in general, some thought must be given in those states without specific requirements as to whether membership approval is necessary, or appropriate, even ifnot necessary.

C. MEMBERSHIl' ApPROVAL AND SECURITIES LAW

CONSIDERATIONS

Approval by the stockholders for the merger or consolidation of cooperatives is expensive and time consuming. Moreover, stockholder approval may trigger Security Exchange Commission (SEC) filing requirements. 26 For these reasons, many regular business corporations avoid stockholder approval if possible. Whether or not it is possible and appropriate in a cooperative merger to avoid a vote of the membership depends on state statutory provisions and the facts of the particular situation.

1. Membership Approval

Techniques have been developed in the regular business corporation area to avoid approval by the stockholders of the surviving corporation and possibly even the acquired corporation

25. At least fifteen states require approval of the plan by two-thirds of the members voting at a

meeting. Su ARK. STAT. ANN. S77-1030 (1981); COLO. REV. STAT. S7-55-112 (1986); IDAHO.CODE S

22-2622A; ILL. ANN. STAT. ch. 32, paras. 111.20(d), 470 (Smith-Hurd Supp. 1987); IOWA CODE

ANN. S 499.64 (West Supp. 1987); Ky. REV. STAT. ANN. S 272.311 (Michie/Bobbs-Merrill 1981); ME. REV. STAT. ANN. tit. 13, S 1951 (1981); MINN. STAT. ANN. S 308.15(4) (West Supp. 1987); MONT. CODE ANN. S 35-17-503 (1985); N.C. GEN. STAT. S 54-161(a) (1982); S.D. CODIFIED LAWS ANN. H7-18-1 (1983); VT. STAT. ANN. tit. 11, S 1061(3) (1984); VA. CODE ANN. S 13.1-339 (1985); WASH . .REV. CODE ANN. S 23.86.220 (West Supp. 1987); WIS. STAT. ANN. S 185.61 (West. Supp.

1986); set also BAARDA, supra note 4, at 119-20 (membership voting requirements for approval of plan). At least three states require approval of the plan by two-thirds voting power. Su CONN. GEN.

STAT. ANN. S33-478 (West 1987); HAW. REV. STAT. S421-21.5 (1985); MD. CORPS. & ASS'NS CODE ANN. SS 3-105(d), 5-527(a)(1985).

Furthermore, at least three states require approval of the plan by a majority of the members voting at a meeting and, in addition, approval of the plan by a majority of the shareholders entitled

to vote. Stt ALASKA STAT. S 10.15.410 (1986); IND. CODE ANN. S 15-7-1-8 (Burns Supp. 1987); UTAH CODE ANN. S 3-1-35 (1982). At least four states require approval of the plan by a majority of the members voting at a meeting. Su N.J. STAT. ANN. S4:13-10 (West 1973); N.D. CENT. CODE S10-15 41 (1985); OR. REV. STAT. S 62.610(3) (1985); PA. STAT. ANN. tit. 15, S 12129(a) (Purdon Supp.

1987). At least one state requires approval of the plan by a majority of the shareholders entitled to

vote. CAL. CORP CODE SS 152, 1103 (West 1977 & West Supp. 1987). 26. Stt 15 U.S.C. S 77e(c) (1982) (unlawful to use any means of interstate commerce to olTer to

sell or olTer to buy securities unless a registration statement is filed); 17 C.F.R. S 230. 145(a) (2)

(1986) (there is an olTer to sell when stockholders vote on a merger or consolidation). For a discussion

of S230.145 and filing exemptions, see infra notes 37-52 and accompanying text.

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in certain types of mergers. These types of mergers are designated as "forward triangular" mergers or "reverse triangular"

mergersY While an exhaustive discussion of triangular mergers is beyond the scope of the Article, a brief discussion of the concept may be useful because triangular mergers serve other purposes as well. 28

A forward triangular merger occurs when the subsidiary of the surviving cooperative acquires another cooperative by exchanging stock in the surviving cooperative for the stock of the acquired cooperative. 29 A reverse triangular merger occurs when the

subsidiary of the surviving cooperative is merged into the acquired cooperative and thus both the surviving cooperative and the acquired cooperative continue in existence. 30

In theory, general business corporations can avoid a vote of the stockholders of the surviving corporation in either type of

triangular merger assuming that enough authorized stock is available to complete the merger.31 Since the surviving corporation is usually the sole shareholder .of its subsidiary, it can approve the

merger of its subsidiary and the acquired cooperative without membership approvaJ.32 Furthermore, it is also possible, in theory, to avoid a vote of the stockholders in the corporation that is acquired in a reverse triangular merger. Because the corporation

survives, albeit as a subsidiary of the surviving corporation, a vote of the stockholders to merge or dissolve may not be needed.

However, what is possible in theory is not always available in practice, especially when the merger involves cooperatives. As

previously mentioned, most state cooperative statutes require a vote of the members to approve a merger. 33 Furthermore, if the

27. See generally Ginnings & Jones, Triangular Mergers in Texas, 12 Hous. L. REV. 307, 308-09 (1975) (discussing fOIWard and reverse triangular mergers). A discussion with Ralph K. Morris of Doherty, Rumble and Butler law firm in Saint Paul, Minnesota indicates that to the best of his knowledge there has been only two cooperative reverse triangular mergers, and all the members of both cooperatives voted to approve the merger in both mergers. Telephone interview with Ralph K. Morris, member of Doherty, Rumble, and Butlerlaw firm (1986).

28. See Raskin, Triangular Mergers: A Useful Technique, 12 COLO. LAW. 1630, 1634 (1983). A reverse triangular merger may be useful if the cooperative to be acquired has an asset, such as a lease or a contract that cannot be assigned. ld. at 1634. Funhermore, a reverse triangular merger may be useful if the acquiring cooperative does not want to assume a contingent or unliquidated debt of the acquired corporation, such as possible liability in pending litigation. ld.

29. Ginnings &Jones, supra note 27, at 308. 30. See id. at 309. 31. See id. at 319 n.89. If the corporation does not have enough authorized stock outstanding to complete the merger, the corporation most likely will have to amend its articles of incorporation to increase the amount of stock it is authorized to distribute. See, e.g., N.D. CENT. CODE ? 10-19.1-10 (1985) (anicles of incorporation must include the number of shares that the corporation is authorized to issue). An amendment to the articles of incorporation generally requires approval by the board of directors and approval by the stockholders. See, e.,I(., id. ? 10-19.1-19 (requiring approval of board of directors and stockholders to amend articles of incorporation). 32. See Ginnings ~ Jones, supra note 27, at 319; Raskin, supra note 28, at 1630. 33. See supra note 25.

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